T-2326-83
Twentieth Century Fox Film Corporation (Plain-
tiff)
v.
The Queen (Defendant)
Trial Division, Addy J.—Vancouver, February 6;
Ottawa, October 1, 1985.
Income tax — Income calculation — Non-residents —
Appeal from reassessments — Plaintiff non-resident corpora
tion producing films in U.S.A. for distribution in Canada by
subsidiary — Subsidiary paying Part XIII withholding tax —
Plaintiff establishing Canadian branch office to eliminate
withholding tax — Evidence Canadian organization not mere
token presence, but carrying on bona fide active business — S.
802 of Regulations, exempting amounts included pursuant to
Part I from withholding tax, applying to exclusion of s. 805,
exempting amounts reasonably attributable to business carried
on in Canada from withholding tax — Rental of films essen
tial part of plaintiff's business and revenues reasonably
attributable to business carried on in Canada — Income Tax
Act, S.C. 1970-71-72, c. 63, ss. 2(3)(b), 115(l)(a)(ii), 212(5) (as
am. by S.C. 1973-74, c. 14, s. 68), 214(13), 215(1) — Income
Tax Regulations, C.R.C., c. 945, ss. 802 (as am. by SOR/79-
424, s. 1), 805(1) — The Canada-United States of America
Tax Convention Act, 1943, S.C. 1943-44, c. 21 (as am. by S.C.
1950, c. 27), Art. II, III.
This is an appeal from reassessments for 1978, 1979 and
1980. The plaintiff, an American corporation, produces films
which, until December 31, 1972, were distributed in Canada by
a subsidiary. The subsidiary paid rentals for the use of the
plaintiffs films in Canada, deducting Part XIII withholding
tax therefrom. Thereafter, the plaintiff established a branch
operation in Canada to eliminate the Part XIII tax. At all
times, contracts made to exhibit the plaintiffs films in Canada
were negotiated by Canadian personnel, although the U.S. head
office reserved the right to sign or approve such contracts.
Advertising, budgets and programs were also developed in the
United States. The same format was used to calculate the net
profits of the branch operation as had been used previously.
Prior to 1973, the subsidiary deducted from its gross rental
receipts the cost of goods sold, which included the amount
charged to it for the use in Canada of the plaintiffs films.
Subsequently, the plaintiff deducted "cost of goods sold"
including direct advertising costs, amortized print costs, and
negative right charges from film rentals received from the
branch (recorded as "merchandise sold"). The negative right
charge was calculated on the basis of a percentage of gross
rental receipts, and was not a direct allocation of the total cost
of producing the negative. It was determined that a net profit of
1.7% of gross revenue would be the appropriate amount of net
profit to attribute to the Canadian branch's operations as it
approximated the average net profit earned by the subsidiary
from the distribution of the plaintiffs films in Canada. In order
to arrive at a net profit equal to the pre-determined rate of
1.7%, the plaintiff adjusted the negative right charges at the
end of each year. Revenue Canada assessed Part XIII tax on
the amounts charged to the branch as "cost of goods sold". The
plaintiff claims that it should not be subject to Part XIII tax.
Held, the appeal should be allowed.
A person who carries on business in Canada is required to
pay income tax on his taxable income. Subparagraph
115(1)(a)(ii) of the Income Tax Act provides that a non-resi
dent's taxable income earned in Canada is the amount of his
income if he had no income other than incomes from businesses
carried on in Canada. However, the plaintiffs income from
film rentals would appear to be subject to withholding tax
under Part XIII. Subsection 212(5) provides that every non
resident shall pay a fixed rate of tax on every amount paid to
him by a Canadian resident as payment for a right to the use in
Canada of a film. Thus the same income would be subject to
Part I tax on net profits, and Part XIII tax on the gross amount
of income. To alleviate the double taxation, section 802 of the
Regulations provides that no withholding tax shall be paid on
amounts included under Part I. Subsection 805(1) exempts
amounts that may reasonably be attributed to the business
carried on in Canada from withholding tax.
The plaintiff incurs production costs for the express purpose
of renting prints of the films. Its film distribution and advertis
ing activities, and public relations promotions are the equiva
lent of sales and sales promotion activities of a manufacturer
who produces goods for sale. The distribution of the product
results in the generation of income and profits. The revenue-
producing activities of the Canadian branch were substantially
the same as the revenue-producing activities of the U.S. Divi
sions. The Canadian organization was not a mere token pres
ence whose real purpose was to avoid Part XIII tax, but it was
carrying on a bona fide active business role. Although film
production is not carried on or controlled by its organization in
Canada, and although most of the major advertising negatives
are produced in the United States, the revenues generated by
the advertising, public relations activities, film printing and
distribution activities, and contract negotiations carried on by
the Canadian branch, must be reasonably attributable to the
business carried on by the plaintiff in Canada.
The commercial success of a film often depends on its
intrinsic public appeal, rather than on the sales ability of the
personnel engaged in negotiating distribution contracts and in
distributing the prints. Furthermore, since none of the produc
tion costs are incurred here, and therefore none of the benefits
directly attributable to the quality of production originate here,
it becomes necessary to ensure that the final figure declared to
be the net profits realized in Canada bears a fair share of the
negative right charges incurred in the United States for the
benefit of the organization as a whole. A fair portion of these
charges, in addition to the local operating expenses, can be
deducted from the revenues earned here in order to arrive at
the true net profit for Canadian business operations. This does
not mean that the revenues themselves are not to be considered
as reasonably attributable to an active business of the plaintiff
carried on in Canada, nor that some proportion of the revenues
is to be excluded.
The main difficulty arises from the fact that, from an
accounting standpoint, the method by which the final amount
of net profits is arrived at does not conform to normal account
ing practices. The calculation of negative right charges repre
sents a juggling of figures to arrive at the predetermined result.
However, the fixing of a predetermined rate of 1.7% to the
gross Canadian receipts from rentals results in a fair and
reasonably accurate calculation of net profit.
The expenses are not in issue but rather the income-produc
ing activities of the plaintiff in Canada. The defendant
approached the problem as if the American head office were
charging a commission or rental to its Canadian branch on the
amount of Canadian sales. The true nature of the relationship
between the Canadian branch and the plaintiff itself cannot
possibly involve a commission or rental: a legal entity cannot
rent to or contract with itself. It is clearly the plaintiff which, at
law, is carrying on business in Canada and not a separate entity
known as the Canadian branch. The fact that a large propor
tion of the actual work in Canada has been allocated to and
performed by independent agents does not affect the situation.
The actual work and production of the agents was under the
immediate supervision and control of the Canadian branch, and
the work itself constitutes actual business activities and opera
tions of the plaintiff.
The defendant relied on United Geophysical Co. of Canada
v. Minister of National Revenue, [1961] Ex.C.R. 283. United
Geophysical is distinguishable as in that case there were two
separate legal entities involved and the relevant part of the
business of the parent corporation was a "mere sideline". Also,
since the United Geophysical case, the law has been amended.
The other cases relied upon by the defendant dealt not with
income, but with net profits and the apportionment between
two jurisdictions not only of revenue, but mainly of expendi
tures. Finally, the authority for imposing taxation cannot be
founded on the Canada-U.S. Tax Convention but on the
Income Tax Act and Regulations. The purpose of the treaty is
to avoid double taxation, not to provide additional taxing
provisions. Thus, the term "permanent establishment" in the
treaty has significance only when considering the treaty itself
and should not be imported into the interpretation of the Act or
Regulations.
Section 802 of the Regulations applies to the exclusion of
section 805, but in any case the plaintiff established that the
rental of films forms an essential part of the plaintiffs business,
and that the revenues from film rentals must necessarily be
considered as reasonably attributable to the business which was
carried on in Canada.
CASES JUDICIALLY CONSIDERED
DISTINGUISHED:
United Geophysical Co. of Canada v. Minister of Na
tional Revenue, [1961] Ex.C.R. 283.
REFERRED TO:
Quemont Mining Corp. v. Minister of National Revenue,
[1967] 2 Ex.C.R. 169; (1966), 66 DTC 5376; Eding-
burgh Life Assurance Company v. Lord Advocate,
[1910] A.C. 143 (H.L.); International Harvester Com
pany of Canada, Ld. v. Provincial Tax Commission,
[1949] A.C. 36 (P.C.); Commissioner of Taxation
(N.S.W.) v. Hillsdon Watts Ltd. (1936-37), 57 C.L.R. 36
(Aust. H.C.); Commissioners of Taxation v. Kirk,
[1900] A.C. 588 (P.C.); Australian Machinery & Invest
ment Co. Ltd. v. Deputy Federal Commissioner of Taxa
tion (Source of Income) (1946), 8 A.T.D. 81 (Aust.
H.C.); Mount Morgan Gold Mining Co. Ltd. v. Commis
sioner of Income Tax (Queensland) (1922-23), 33 C.L.R.
76 (Aust. H.C.); Gladden, J.N. Estate v. The Queen
(1985), 85 DTC 5188 (F.C.T.D.).
COUNSEL:
P. N. Thorsteinsson, Q.C. and L. A. Green for
plaintiff.
J. R. Power, Q.C. and Jane Meagher for
defendant.
SOLICITORS:
Thorsteinsson, Mitchell, Little, O'Keefe &
Davidson, Vancouver, for plaintiff.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
ADDY J.: The plaintiff is appealing its reassess
ment by the defendant for income tax purposes for
the years 1978, 1979 and 1980.
There is very little dispute as to the facts in this
case. The decision will ultimately depend mainly
on the interpretation of the applicable statutory
provisions and, to some extent, on the proper
approach to the problem from an accounting
standpoint. Most of the facts are to be found in a
very detailed agreed statement of facts filed at
trial. The most relevant paragraphs of the agreed
statement are the following:
1. The Plaintiff is a Delaware corporation resident in Los
Angeles, California.
2. The Plaintiff produces and distributes motion pictures, video
tapes and television programs and is involved in television
broadcasting, film processing, record and music publishing and
other related fields.
3. Prior to December 31, 1972 all phases of the distribution in
Canada of the Plaintiffs theatrical and television product was
carried on by a subsidiary of the Plaintiff, Twentieth Century
Fox Corporation Limited ("Fox Canada") pursuant to a license
agreement between Fox Canada and Twentieth Century Fox
Inter-America Inc. ("Fox"), a subsidiary of the Plaintiff, resi
dent in the United States. Between April 28, 1972 and Decem-
ber 31, 1972, pursuant to an agency agreement dated April 28,
1972, Fox Canada distributed the Plaintiffs film in part
through the efforts of its own employees and in part through its
independent agent, Bellevue Film Distributors Limited
("Bellevue").
4. Pursuant to the license agreement with Fox, Fox Canada
paid to Fox rentals for the use of the Plaintiffs films in
Canada. Pursuant to the agency agreement with Fox Canada,
between April 28, 1972 and December 31, 1972 those rentals
other than those derived from television were collected on
behalf of Fox Canada by its agent, Bellevue.
5. On or about November 20, 1972 the decision was made by
the Plaintiff to establish a branch operation in Canada to
handle the distribution in Canada of the Plaintiffs theatrical
and television product, effective the beginning of business
December 31, 1972.
6. On or about January 2, 1973 all of the assets of Fox
Canada, except the real property located in Calgary, Alberta
were transferred to the Plaintiff in consideration for the Plain
tiff assuming all of the obligations of Fox Canada.
7. By agreement dated January 2, 1973 the license agreement
between Fox and Fox Canada was terminated, effective
December 30, 1972, and at all material times thereafter the
Plaintiff distributed its theatrical and television product in
Canada through its branch offices located in Toronto and
Montreal and its independent agent, Bellevue.
8. Pursuant to an agreement dated January 2, 1973 the Plain
tiff terminated the agency agreement between Fox Canada and
Bellevue and entered into an agreement directly with Bellevue
that adopted the terms of the agreement of April 28, 1972
between Fox Canada and Bellevue. Pursuant to the agreement
of January 2, 1973 Bellevue had the same obligations towards
the Plaintiff as it had had towards Fox Canada.
9. After December 30, 1972 the Plaintiffs branch operations
in Canada were carried on in the same manner as Fox Canada
had operated in Canada when it had distributed the Plaintiffs
product in Canada.
10. Certain employees of Fox Canada became employees of the
Plaintiff and remained in Toronto to operate the branch.
11. The offices of the employees who dealt with the motion
picture theatres for the branch in Toronto, including those who
had previously been employed by Fox Canada, were at all
material times after December 30, 1972 located at Bellevue's
offices in Toronto.
12. Both during the years that Fox Canada distributed the
Plaintiffs product in Canada and the years that the Plaintiff
operated through its Canadian branch, the contracts made with
Canadian exhibitors to exhibit the Plaintiffs films in Canada
were negotiated by personnel operating out of the location in
Canada (of either the subsidiary or the branch) but were signed
by the Plaintiffs personnel operating out of Los Angeles.
13. Personnel located in Canada did not have the authority to
sign documents that could bind the Plaintiff. Advertising,
budgets and programs were also developed in Los Angeles
based on input from Canadian employees.
14. By letter dated June 20, 1980 the Plaintiff terminated the
agency agreement with Bellevue except for the non-theatrical
distribution.
15. By agreement dated October 1, 1980 between the Plaintiff
and Astral Films Limited ("Astral"), Astral agreed to provide
the service of distributing the films to the theatres for a fee.
After that date the Plaintiff's theatrical distribution was con
ducted through the branch and its agent, Astral, and its
non-theatrical distribution was conducted through the branch
and its agent, Bellevue. Film for use on television was dealt
with throughout by the Plaintiff's branch employees.
16. Prior to December 31, 1972 Fox Canada paid Part I
income tax at a rate of approximately 50% under the Income
Tax Act on its income earned in Canada and deducted Part
XIII tax of 10% under the Income Tax Act from film rentals it
paid to Fox for the use of the Plaintiffs films in Canada. The
withholding tax at the time Fox Canada ceased distributing the
Plaintiffs product in Canada was averaging $400,000 per year.
17. The decision by the Plaintiff to establish a branch opera
tion in Canada to handle the distribution in Canada of its
theatrical and television product was made in order to eliminate
the Part XIII withholding tax and pay only Part I tax on the
income from business carried on by it in Canada.
18. The Plaintiff claims in this action that it is not subject to
any Part XIII withholding tax on rentals received by it from
Canadian exhibitors. It claims that it is only subject to Part I
tax on its branch's net income from carrying on business in
Canada.
19. The Plaintiff, in calculating the net profits attributable to
the operations of its branch in Canada, prepared financial
statements using the same format as had been used in earlier
years when the Canadian operations had been conducted
through its subsidiary, Fox Canada.
20. Prior to 1973 the Plaintiffs subsidiary (Fox Canada) in
calculating its Canadian profits, deducted from its gross rental
receipts an amount described as its cost of goods sold which
included the amount charged to it by Fox for the use by it in
Canada of the Plaintiffs films.
21. After the Plaintiff started to distribute its product through
its Canadian branch, it was decided to keep a current account
in the books of the Plaintiff and the branch during the year, of
the amounts due by the branch to its head office. An inter-com
pany account was accordingly set up during the years the
branch operated in Canada which served as a control account
through which would flow all payments from the branch to the
Plaintiff. This account was reflected in the branch balance
sheet as an amount "Due to Twentieth Century Fox Film
Corporation" under the "Liabilities" column.
22. In the branch's financial statements the Plaintiff recorded
the film rentals received by the branch as "merchandise sold
during year (Film Rental)". In order to arrive at the branch's
gross trading profit for the year the Plaintiff deducted an
amount described as the branch's "cost of goods sold" in the
year, which in fact reflected the costs allocated to the branch
by the Plaintiff for the product distributed by the branch.
23. The cost of goods sold amounts were, in each of the years in
question made up of the costs of direct advertising, print costs
subject to amortization and the negative rights charges or
producer's share.
24. The negative rights charges reflected a charge to the branch
to recover a portion of the cost incurred by the Plaintiff to
produce the master negative. Every month the Plaintiff allocat
ed a cost to the branch for negative rights charges. This cost
was calculated on the basis of a percentage of the gross rental
receipts and was not a direct allocation of the cost of producing
the negative.
25. The negative cost was made up of all the costs of shooting
the motion picture, including the costs of all the actors and
actresses and cameramen and the cost of the script.
26. During the years that the Plaintiff distributed its films in
Canada whether through Fox Canada or its branch, the Plain
tiff did the actual shooting of the motion pictures and devel
oped the original negatives made from the shooting, from which
positive prints were ordered by Fox Canada or the Canadian
branch for distribution in Canada.
27. During the years that the Plaintiff was involved in film
distribution in Canada through both Fox Canada and its
Canadian branch, neither Fox Canada nor the Canadian
branch were engaged in the production of films for theatre or
T.V. in Canada. The Plaintiff from time to time produced films
in Canada during those years but its production crews in
Canada had no effective connection with Fox Canada or the
Plaintiffs Canadian branch.
28. From the negatives or duplicate negatives of the films
produced by the Plaintiff were made positive prints for distribu
tion to the theatres for exhibition.
29. The cost of the prints was borne by Fox Canada in the
years it operated in Canada and by the Plaintiffs branch in the
years during which it operated in Canada. This cost was then
amortized by both Fox Canada and the branch. In the years the
branch operated in Canada the amortized print costs were
reflected each year in the financial statements of the branch as
a portion of the cost of goods sold figure.
30. It was determined that a net profit of 1.7% of gross revenue
would be the appropriate amount of net profit to attribute to
the Plaintiffs Canadian branch operations as this percentage
approximated the average net profit which had been earned by
Fox Canada in the years in which it had distributed the
Plaintiffs films in Canada.
31. The branch therefore determined its net profit on which
Canadian taxes were paid in each of the 1978, 1979 and 1980
taxation years by applying the pre-determined rate of 1.7% to
the Plaintiffs gross Canadian film rentals.
32. In order to arrive at such a net profit for the 1978, 1979
and 1980 taxation years, which would be equal to the predeter
mined rate of 1.7% in each of those years, the Plaintiff, at the
end of each year, adjusted the negative rights charges ("pro-
ducer's share") which had been charged to the branch.
49. After 1972 the Plaintiffs branch reported a net profit for
its Canadian operations of approximately 1.7% of the Plaintiffs
gross Canadian film rentals received by it on which it paid tax
under Part I of the Income Tax Act. On October 18, 1982
Revenue Canada assessed Part XIII tax on the amounts
charged to the Plaintiffs branch by the Plaintiff and described
in the schedules in the branch's income tax returns as the cost
of goods sold. It is these assessments for 1978 to 1980 which
are the subject of dispute in this action.
50. On October 18, 1982 the Minister of National Revenue
similarly assessed the 1973-1977 taxation years. Those assess
ments are now agreed to be statute-barred and accordingly are
not involved in this action:
57. It is now agreed that in any event video tape receipts are
exempt from Part XIII tax by virtue of the provisions of Article
XIIIC of the Schedule to the Canada-United States of America
Tax Convention Act, 1943, as amended, and the amounts
thereof referred to in paragraphs 54 to 56 should not have been
so taxed.
Other relevant facts, which are founded on
admissions in the pleadings or on admissions at
trial or are to be deduced from the evidence at
trial are detailed hereunder:
1. The plaintiff, a non-resident corporation, was
carrying on an active business in Canada at all
relevant times.
2. There is no issue between the parties as to the
fairness of the figure of 1.7% of gross revenue for
each of the three years in question. That propor
tion of 1.7% was intended to represent not only the
minimum amount of net revenue which would be
considered as having been earned but also the
maximum.
3. The Canadian branch of the plaintiff corpora
tion carried on substantially the same business as
the four Divisions of the plaintiff situated in the
United States, but separate accounting was not
carried out in the United States Divisions as such
accounting was not required for United States
income tax purposes. The only reason why sepa
rate accounting was carried out by the Canadian
branch was to determine the amount to be payable
for Canadian income tax purposes.
4. There is no dispute as to the accuracy of the
figures in the accounts but only as to their applica
tion and use.
5. There was a constant daily liaison between the
manager of the Canadian branch and head office
in Los Angeles regarding the distribution and mar
keting of films. Distribution contracts in Canada
were negotiated here by the branch but signed at
head office or signed here after approval by head
office.
6. Bellevue physically handled and distributed to
the theatres and also collected back from them the
35-millimetre prints of the films. It also acted as
agent to collect the monies due. It paid for the
printing cost in advertising bills and, after deduct
ing its share of the cost, its commission and a
Canadian withholding tax of 15%, it turned over
the balance to the Canadian branch which deposit
ed the monies in its Canadian accounts and, after
setting aside some monies for its own operating
expenditures, transferred the balance to head
office on a regular basis.
7. Part XIII income tax was assessed as follows:
Plaintiff's Amount
Canadian Subjected to
Year Gross Rentals Part XIII tax Part X111 tax
1978 $14,770,819 $12,723,853 $1,908,578
1979 11,81 1,100 10,352,301 1,552,845
1980 26,071,881 23,069,430 3,460,415
TOTAL $52,653,800 $46,145,584 $6,921,838
8. In addition to conceding that no interest should
be assessed on Part XIII tax and that Part XIII
tax on rentals and royalties relating to video tapes
should be deleted, counsel for the defendant,
during final argument, conceded that the print
costs and advertising costs hereinafter set forth are
amounts which can reasonably be attributed to
Canadian business as mentioned in the concluding
words of section 805 of the Income Tax Regula
tions [C.R.C., c. 945]. The amounts so conceded
are as follows:
PRINT ADVERTISING TOTAL
1978 $ 275,186 $1,779,751 $2,054,937
1979 1,008,368 1,708,097 2,716,465
1980 1,136,652 3,207,602 4,344,254
TOTAL $2,420,206 $6,695,450 $9,115,656
Part XIII tax being conceded
($9,115,656 x 15%) $1,367,348
The above figures were filed on consent as
exhibit 60.
As a non-resident person carrying on business in
Canada, the plaintiff is taxable under Part I of the
Income Tax Act [R.S.C. 1952, c. 148 (as am. by
S.C. 1970-71-72, c. 63, s. 1)] by virtue of para
graph 2(3)(b) and the provisions of subparagraph
115(1)(a)(ii) which read as follows:
2....
(3) Where a person who is not taxable under subsection (I)
for a taxation year
(b) carried on a business in Canada, ...
at any time in the year or a previous year, an income tax shall
be paid as hereinafter required upon his taxable income earned
in Canada for the year determined in accordance with Division
D.
115. (1) For the purposes of this Act, a non-resident person's
taxable income earned in Canada for a taxation year is the
amount of his income for the year that would be determined
under section 3 if
(a) he had no income other than
(ii) incomes from business carried on by him in Canada,
However, the nature of the plaintiffs income,
that is, film and video tape rentals, would appear
to render it subject to Canadian withholding tax
under Part XIII of the Act. The relevant taxing
provision would be subsection 212(5) [as am. by
S.C. 1973-74, c. 14, s. 681:
212... .
(5) Every non-resident person shall pay an income tax of
25% on every amount that a person resident in Canada pays or
credits, or is deemed by Part I to pay or credit, to him as, on
account or in lieu of payment of, or in satisfaction of, payment
for a right in or to the use of
(a) a motion picture film, or
(b) a film or video tape for use in connection with television
that has been or is to be used or reproduced in Canada.
(It is to be noted that, for taxpayers residing in the
United States, the rate of tax has been fixed at
15% in lieu of 25% by virtue of a Canada-U.S. tax
convention.)
It thus appears that, in considering these provi
sions without more, the same income would be
subject to two separate kinds of taxes, that is the
normal tax on corporate income based on net
profits under Part I and fixed tax of 15% on the
gross amount of income pursuant to Part XIII,
with the payors being obliged, pursuant to subsec
tion 215(1), to deduct at source this last-men
tioned amount from all payments made to a non
resident person. To allow relief against this burden
of double taxation, Parliament included in Part
XIII subsection 214(13) the relevant portion of
which reads as follows:
214... .
(13) The Governor in Council may make general or special
regulations, for the purposes of this Part, prescribing
(c) where a non-resident person carried on business in
Canada, what amounts are taxable under this Part or what
portion of the tax under this Part is payable by that person.
Pursuant to this last-mentioned provision the fol
lowing relevant regulations were made by the Gov
ernor General in Council:
Section 802 [as am. by SOR/79-424, s. 1] of the
Regulations:
802. For the purposes of paragraph 214(13)(c) of the Act,
the amounts taxable under Part XIII of the Act in a relevant
taxation year of a taxpayer are amounts paid or credited to the
taxpayer in the relevant taxation year other than amounts
included pursuant to Part I of the Act in computing the
taxpayer's income from a business carried on by it in Canada.
Under the heading Other Non-Resident Persons
subsection 805(1) of the Regulations reads as
follows:
805. (1) Where a non-resident person carries on business in
Canada he shall be taxable under Part XIII of the Act on all
amounts otherwise taxable under that Part except those
amounts that may reasonably be attributed to the business
carried on by him in Canada.
Articles II and III of the schedule to The Cana-
da-United States of America Tax Convention Act,
1943 [S.C. 1943-44, c. 21 (as am. by S.C. 1950, c.
27)] read as follows:
ARTICLE II
For the purposes of this Convention, the term "industrial and
commercial profits" shall not include income in the form of
rentals and royalties, interest, dividends, management charges,
or gains derived from the sale or exchange of capital assets.
Subject to the provisions of this Convention such items of
income shall be taxed separately or together with industrial and
commercial profits in accordance with the laws of the contract
ing States.
ARTICLE III
1. If an enterprise of one of the contracting States has a
permanent establishment in the other State, there shall be
attributed to such permanent establishment the net industrial
and commercial profit which it might be expected to derive if it
were an independent enterprise engaged in the same or similar
activities under the same or similar conditions. Such net profit
will, in principle, be determined on the basis of the separate
accounts pertaining to such establishment. In the determination
of the net industrial and Commercial profits of the permanent
establishment there shall be allowed as deductions all expenses,
wherever incurred, reasonably allocable to the permanent es
tablishment, including executive and general administrative
expenses so allocable.
Thus, were it not for sections 802 and 805 of the
Regulations, then pursuant to subsection 212(5) of
Part XIII (formerly Part III) of the Act as well as
Article II of the schedule to The Canada-United
States of America Tax Convention Act, 1943,
rentals received from residents of Canada for the
plaintiff's film and video tapes would be subject to
tax under that Part of the Act. Section 805 excepts
only the amount of income which may reasonably
be attributed to the business carried on in Canada
by the taxpayer. Section 802 on the other hand in
effect provides that no withholding tax (i.e., Part
XIII tax) shall be paid on amounts included in
Part I.
The plaintiff produces films in the United States
and, in order to do so, incurs all the related
production costs for the express object and purpose
of renting prints of the films to various outlets
such as TV stations and cinemas. Its film distribu
tion activities and the advertising activities and
public relations promotions connected with them
are the equivalent of the sales and the sales promo
tion activities of a manufacturer who produces
goods for sale. The distribution of the product
results in the generation of income and profits
which of course is the ultimate goal of the entire
undertaking. The revenue-producing activities of
the plaintiff's Canadian branch were substantially
the same as the revenue-producing activities which
the four U.S. Divisions of the plaintiff carried out
south of the border. Therefore, this is not the case
of a U.S. firm being engaged in business dealings
in Canada, promoted, controlled and carried out
entirely from the United States without a branch
or organization in Canada. On the contrary, the
Canadian business was promoted and carried on
by and through the plaintiffs Canadian branch,
although the company's U.S. head office reserved
the ultimate right to sign or approve distribution
contracts and was in almost daily communication
with its Canadian manager. The facts convince me
that the Canadian organization was by no means a
mere token presence whose real purpose was
merely to avoid Part XIII tax but, that it was
carrying on here a bona fide active business role,
notwithstanding the fact that decision to replace
the former Canadian company (Fox Canada) by a
Canadian branch of the U.S. company was taken
mainly for the purpose of avoiding Part XIII tax.
Fox Canada, in my view, had formerly been carry-
ing on in Canada an active business role in every
sense of the word and that role was entirely
assumed and taken over by the Canadian branch
of the plaintiff.
Although film production, even in the case of
productions actually filmed here, is not carried on
or controlled by its organization in Canada and
although most of the major advertising negatives
are also produced in the U.S.A., the Canadian
advertising, public relations activities, film print
ing and distribution activities and contract
negotiations connected thereto are carried on by
the plaintiff in Canada through its Canadian
branch and the resulting revenues must necessarily
result from or be considered as reasonably
attributable to the business being carried on by the
plaintiff in this country.
It is quite true that the commercial success of a
film often depends to a greater degree on its
intrinsic public appeal which in turn will depend
on many intangible factors such as the reputation
of the cast, the originality or the timeliness of the
tale, the techniques of the director, the lavishness
of the production or the musical appeal of the
score, rather than on the business acumen and
sales ability, or on the public relations and direct
advertising activities of the personnel engaged in
negotiating distribution contracts and in distribu
ting the prints. Furthermore since, in the present
case, none of the production costs are incurred
here and therefore none of the benefits directly
attributable to the quality of production originate
here, it becomes necessary to ensure that the final
figure declared to be the net profits realized in
Canada bears a fair share of the negative right
charges incurred in the U.S.A. for the benefit of
the organization as a whole. A fair portion of these
charges, in addition to the local operating
expenses, can be deducted from the revenues
earned in this country in order to arrive at a figure
which would represent the true net profit for
Canadian business operations of the plaintiff. This
does not mean, however, that the revenues them
selves are not to be considered as reasonably
attributable to an active business of the plaintiff
carried on in Canada nor does it mean that some
proportion of the revenues is to be excluded. In the
case at bar, the Minister of National Revenue does
not quarrel with the allocation of production costs
or negative rights. This has been confirmed by the
assessments and conceded by the defendant.
Indeed, counsel for the defendant repeatedly
stated that the Minister is, in fact, satisfied with
what he referred to as the "bottom line" figure.
What the defendant is seeking to do is to remove
part of that revenue from revenue which the plain
tiff claims to be reasonably attributable to its
business in Canada and to tax that amount.
The main difficulty arises from the fact that,
from an accounting standpoint, the method by
which the final amount of net profits is arrived at,
for each of the years in dispute, does not conform
to normal accounting practices. I do not accept the
expert evidence tendered which purports to show
that it does. Indeed, I would say that the calcula
tions of negative right charges do not make sense
and represent nothing more than a juggling of
figures in order to arrive at a predetermined result.
A party cannot avoid taxation by failing to
account for either income or liabilities in accord
ance with generally accepted accounting princi
ples. It is equally true that a party should not be
held liable for taxation merely because of a failure
to follow those principles or to use proper ter
minology in the accounts. Assessment must in all
cases be based on the true nature of the transac
tions and operations which the books of account
purport to reflect. (Quemont Mining Corp. v.
Minister of National Revenue, [1967] 2 Ex.C.R.
169, at pages 200-202; (1966), 66 DTC 5376, at
page 5395; Edingburgh Life Assurance Company
v. Lord Advocate, [1910] A.C. 143 (H.L.), at page
163.) Terminology used in the books of account or
supporting documents merely constitutes circum
stantial or indirect evidence of the apparent nature
of various transactions. Like all circumstantial
evidence, unless supported by other evidence, it
should not be considered as conclusive and must be
disregarded when clearly contradicted by other
direct or more reliable evidence.
Both parties are of the view that the fixing of a
predetermined rate of 1.7% to the gross Canadian
receipts from rentals results in a fair and reason
ably accurate calculation of net profits. The inter
mediate figures subsequently inserted, purporting
to represent true negative right charges, are artifi
cially adjusted in order to arrive at this result.
They are therefore ficticious as they do not flow
from an actual calculation of those charges and a
proportionate allocation of the charges to the
Canadian branch as compared to the business
generated and carried out by the American Divi
sions of the plaintiff. If an attempt were made to
do this, the accounting task might well prove to be
a very considerable one. It would entail many
detailed calculations, estimates and allocations on
the part of the plaintiff thereby creating equal
difficulties for the defendant in attempting to
verify these figures. It would involve detailed stud
ies of the activities of all the American Divisions in
order to determine the true allotment of negative
rights against the Canadian operation. Since the
American branches do not account individually for
their own operations, the task would undoubtedly
prove to be a monumental one. A pragmatic solu
tion to that problem was adopted by the plaintiff
and the end result was approved by the defendant
as representing the final figure resulting from a
fair allocation of negative rights.
It may well be that the defendant would be
entitled to refuse to accept this method of allocat
ing negative rights as part of the cost but that is
not the question in issue before me. The expenses
are not in issue but, rather, the income-producing
activities of the plaintiff in Canada. The defend
ant, in arguing the case, approached the problem
as if the U.S. head office were charging a commis
sion or a rental to its Canadian branch on the
amount of Canadian sales. Regardless of what
certain expressions in some of the accounting
documents might tend to indicate, the true nature
of the relationship between the Canadian branch
of the plaintiff and the plaintiff itself cannot poss
ibly involve a commission or a rental: a legal entity
cannot rent to or contract with itself. It is clearly
the plaintiff which, at law, is carrying on business
in Canada and not a separate entity known as the
Canadian branch. Indications to the contrary in
the books of account must therefore be disregard
ed. For that same reason I do not accept the
conclusions of the expert called on behalf of the
defendant, as he treated the Canadian branch
from an accounting standpoint as if it were a
separate legal entity contracting with the U.S.
organization of the plaintiff.
In the circumstances of the present case, the
fact that a large proportion of the actual work in
Canada has been allocated to and performed by
independent agents does not affect the situation.
The actual work and production of the agents was
under the immediate supervision and control of the
Canadian branch of the plaintiff and the work
itself constitutes in every way actual business
activities and operations of the plaintiff in Canada
performed through those agents as well as directly
by the plaintiff. The fact that a company chooses
to have certain of its business activities carried out
by agents does not of itself prevent those activities
from being the business operations of the com
pany. There may well be situations where a foreign
taxpayer, in order to avoid liability for tax under
Part XIII, would create either a fictitious or non-
active presence or a sham branch organization in
this country in an endeavour to impart the charac
ter of revenue from a business actively carried on
by it in Canada, to what is in essence a rental, a
commission, a royalty or some other such passive
form of income paid to it by Canadian resident
individuals or firms who are the persons who are in
fact actively carrying on the business here. I am
satisfied, however, that, having regard to the
activities of the plaintiff in Canada, such is not the
case here. Illustrative of that conclusion is the fact
that the Canadian branch is operating in exactly
the same manner as was the former Canadian
subsidiary of the plaintiff. That subsidiary had of
course been paying Part XIII tax and it would
appear that it would have had no reason to exist
here at all had it not been actively engaged in
promoting its own business in this country.
The defendant relied quite heavily on the case of
United Geophysical Co. of Canada v. Minister of
National Revenue, [1961] Ex.C.R. 283, in which
Thurlow J., as he then was, held that the plaintiff
company, a wholly-owned U.S. subsidiary of
another U.S. corporation, was subject to withhold
ing tax on rentals which it paid to its parent U.S.
corporation for the latter's Canadian assets which
were leased to it. The case however is quite distin
guishable on the facts. There were two separate
legal entities involved and the relevant part of the
business of the parent corporation in that case was
described as a "mere sideline"—refer pages 292
and 293 of the above-mentioned report:
The other and wider view of the scope of the Corporation's
business is that it embraced the supplying of geophysical
services to clients but included as a sideline after May 1, 1955,
the providing at approximately cost to the appellant, its wholly-
owned subsidiary, of administrative, supervisory and other ser
vices, as well as equipment for the appellant's use. This, I think,
is the correct view .... [Emphasis added.]
The learned Judge also stated at pages 293 and
294:
Accordingly, in this view, as well, of the scope of the Corpora
tion's business, I am of the opinion that the "rental" for the
equipment was income from that part of its business which was
carried on in the United States and could not reasonably be
attributed to any part of the business which may have been
carried on by the Corporation in Canada. Such rental would
not, therefore, be taxable under Part I of the Act or be included
in computing the Corporation's income for the purposes of that
Part. [Emphasis added.]
In addition, in the above-mentioned case, there
is no indication that the U.S. parent corporation
ever paid any income or ever filed any return
under Part I of the Act.
More importantly, however, since the United
Geophysical case was decided, the law has been
amended in a most significant way. The law as
applicable to the years involved in United Geo
physical case, 1955/6, contained the withholding
tax provisions in Part III (now Part XIII) and the
"reasonably attributable" rule now found in Regu
lations section 805 was found in subsection 31(1)
of the Act [R.S.C. 1952, c. 148]. The rule about
no withholding on amounts included in income
under Part I now found in Regulations section 802
was contained in an earlier version of Regulations
section 805. Regulations section 805 was amended
in 1956 to substitute the "reasonably attributable"
test for the "no withholding tax if included in Part
I" test and subsection 31(1) of the Act was
amended in 1960 [S.C. 1960, c. 43, s. 6] to remove
from the statute the "reasonably attributable" test.
Section 802 of the Regulations was changed, effec
tive 1978, to apply the "no withholding tax if
included in Part I" test to all non-resident persons
carrying on business in Canada.
The defendant also relied on the following cases
namely: International Harvester Company of
Canada, Ld. v. Provincial Tax Commission,
[1949] A.C. 36 (P.C.); Commissioner of Taxation
(N.S.W.) v. Hillsdon Watts Ltd. (1936-37), 57
C.L.R. 36 (Aust. H.C.); Commissioners of Taxa
tion v. Kirk, [1900] A.C. 588 (P.C.); Australian
Machinery & Investment Co. Ltd. v. Deputy Fed
eral Commissioner of Taxation (Source of
Income) (1946), 8 A.T.D. 81 (Aust. H.C.); Mount
Morgan Gold Mining Co. Ltd. v. Commissioner of
Income Tax (Queensland) (1922-23), 33 C.L.R.
76 (Aust. H.C.). However, all of these cases dealt
not with income but with net profits and the
apportionment between two jurisdictions not only
of revenue but mainly of expenditures. Finally, the
authority for imposing taxation cannot be founded,
as the defendant seemed to argue, on the Canada-
U.S. Tax Convention but only on the Income Tax
Act and Regulations. The purpose of the treaty is
to avoid double taxation and not to provide addi
tional taxing provisions. I recently applied this
principle in Gladden, J.N. Estate v. The Queen
(1985), 85 DTC 5188 (F.C.T.D.). Thus, the term
"permanent establishment" in the treaty and on
which the defendant relies to some extent, has
significance only when considering the treaty itself
and should not be imported into the interpretation
of the Income Tax Act or its Regulations.
For the above reasons I conclude that, in the
circumstances of the present case, section 802 of
the Regulations applies to the exclusion of section
805. Should that not be the case, I am in any event
satisfied that the plaintiff has established on the
facts that the rental of films in Canada as in the
United States and other countries forms an essen
tial and integral part of the business of the plain
tiff and that the revenues from film rentals must
necessarily be considered as reasonably attribut-
able to the business which was carried on in
Canada during the years in issue. No logical nor
legal reason exists for arriving at a different
conclusion.
A judgment will therefore issue referring the
matter back to the Minister of National Revenue
for reassessment for the years 1978, 1979 and
1980 on the basis that the plaintiff was taxable
solely pursuant to Part I of the Income Tax Act
and that no withholding tax was payable pursuant
to Part XIII.
The plaintiff will be entitled to its costs.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.